Rio Tinto and BHP Billiton are optimistic if they think their iron ore joint venture will pass muster in the powerful competition department of the European Commission.

That’s where the latest deal will be made or killed off, and judging by comments made by the Commission last November, the latter seems the more likely outcome.

The news came thick and fast this morning. Rio went into a trading halt, all but confirming that the $US19.5 billion Chinalco deal was buried. BHP revealed its involvement in a separate announcement that seemingly pre-empted the Rio statement. An hour later Rio revealed plans to raise up to $US15.2 billion ($A19 billion) in an issue to shareholders, and officially killed off the Chinalco deal. The cash raised will go a long way to paying off Rio’s $US20 billion in debt due over the next two years.

Then BHP revealed the terms of the joint venture, stressing its stand alone and independent nature (no doubt to try and keep the European Commission at bay).

“Rio Tinto and BHP Billiton today signed a non-binding agreement to establish a production joint venture covering the entirety of both companies’ Western Australian iron ore assets. The joint venture will encompass all current and future Western Australian iron ore assets and liabilities and will be owned 50:50 by BHP Billiton and Rio Tinto.

“The joint venture is expected to unlock significant value from the companies’ overlapping, world-class resources. Both companies believe the net present value of these unique production and development synergies will be in excess of US$10 billion (100 per cent basis).

The statement then detailed how these “synergies” would be obtained. The most important from the competition point of view was this:

“The joint venture will operate as a cost centre and deliver iron ore, in equal volumes, to ships designated by BHP Billiton and Rio Tinto to sell independently through their own marketing groups. In order to equalise the contribution value of the two companies, BHP Billiton will pay Rio Tinto US$5.8 billion for equity type interests at financial close to take its interest in the joint venture from 45 per cent to 50 per cent.

“Senior management of the entity will be determined jointly on the basis of the ’best person for the job‘ with broadly equal participation from Rio Tinto and BHP Billiton.

“The initial Chairman of the nonexecutive owners’ council will be Sam Walsh, currently Rio Tinto Chief Executive Iron Ore, and the initial CEO of the production joint venture will be BHP Billiton Iron Ore President, Ian Ashby. Future CEOs will be appointed by mutual consent.”

And that will raise the prospect of a re-run (in a re-worked version) of the takeover bid that BHP terminated last November. Independent marketing groups are well and good, convincing the EC of that independence will be a major test.

That proposal will upset Chinese buyers of iron ore, which have yet to settle with the two Australian companies and will make them more determined to push for cuts bigger than those agreed to with Japanese, Taiwanese and South Korean mills in the past week.

Other big steel giants, such as Posco in Korea, ArecelorMittal, the world’s biggest (and an indirect shareholder in Fortescue) won’t be happy. They all objected to the original BHP takeover offer for Rio.

More important though will be the attitude of the European Commission which was grumbling about the original takeover offer.

Early reports have accepted some linking with BHP, especially in iron ore.

This is the statement the European Commission’s Competition department issued last November when BHP terminated the offer:

“The European Commission intends to close its investigation under the EU Merger Regulation into BHP Billiton’s proposed acquisition of Rio Tinto and not adopt a final decision as BHP Billiton has informed the European Commission that it has abandoned the proposed acquisition and has withdrawn its notification. The Commission is satisfied that the planned transaction has effectively been abandoned and will not proceed.

“In a press release dated 25 November 2008 BHP Billiton announced that even if the Commission were to clear the proposed transaction unconditionally, BHP Billiton’s directors intended to recommend that its shareholders vote against approving the transaction.

“The press release explained that due to the continued deterioration of near term global economic conditions the company’s management believed that the acquisition of Rio Tinto was no longer in the best interests of BHP Billiton shareholders. On 26 November 2008 BHP Billiton decided to formally abandon their pre-conditional offer on Rio Tinto and withdrew their notification.

“The Commission had opened an in-depth investigation of BHP Billiton’s proposed acquisition of Rio Tinto on 4 July 2008 (see here) because the Commission’s initial market investigation had indicated that the proposed takeover raises serious doubts as to its compatibility with the Single Market and could have resulted in higher prices and reduced choice for these companies’ customers.”

How a joint venture will meet those objections and suspicions will be the key to any re-worked deal to be offered to the EC for approval. If some Rio shareholders and commentators doubted that Chinalco would not be in a position to influence Rio on pricing, it’s hard to see how BHP and Rio can’t help but get an inside view of what each is doing in an iron ore joint venture.

Peter Fray

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